BASF India-Cyanamid Agro merger -- Shareholder-value`cide'

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BASF India: Buy at declines

Cyanamid Agro: Sell

Aarati Krishnan

FALLING farm prices and the pressure to step up research and development spending have sparked a spate of mergers and acquisitions (M&As) in the global agrochemical industry.

This has had its impact on the Indian arms of multinational companies too, with almost every leading player in India putting through a consolidation and restructuring exercise over the past year.

At the global level, such mergers are no doubt structured to take into account the best interests of shareholders in the individual merging companies. But when a global merger is replicated by the local arms of multinationals, it could have an unintended impact on the valuations of the merging entities. The recently proposed merger between BASF India, a 51 per cent subsidiary of BASF AG, and Cynamid Agro, a 69 per cent subsidiary of Cyanamid Global (the crop protection business of American Home Products), is a case in point.

Different structures

In the global acquisition, BASF AG outbid a host of contenders to acquire the crop-protection business of American Cyanamid in an all-cash deal. At the asking price of $3.8 billion, termed as a bit stiff by industry watchers, BASF AG ended up paying twice the annual sales figure (of $1.7 billion) of Cyanamid Agro for the acquisition. BASF AG outlined several benefits from this acquisition -- a new position for BASF among the top three players in the agchem market, annual cost savings of $250 million through synergies and job cuts, and an enhanced R&D pipeline.

But in the Indian context, the merger is being structured differently. Shortly after the global acquisition, American Cyanamid's 68.99 per cent stake in the Indian arm was transferred to the BASF group. Now, the domestic operations of Cyanamid Agro and BASF India are being integrated by a merger of the former with the latter, through a stock swap. At a board meeting on January 31, the swap ratio for the merger of Cyanamid Agro with BASF India was fixed at 5:2, that is, BASF India will issue two shares for every five held by Cyanamid shareholders.

Swap ratio: Out of sync with market

This swap ratio is a bolt from the blue for the shareholders of Cyanamid Agro, for it is way out of sync with the relative market prices of the two stocks. Just before the announcement, the BASF India stock hovered at Rs 94 while the Cyanamid Agro scrip traded at Rs 56.

Since the basis for the valuation has not been disclosed, it is difficult to judge the merits or otherwise of this ratio. But going solely by the value of the shares Cyanamid Agro shareholders would receive in lieu of their holdings, they have got a lower consideration per rupee of sales than their counterparts in American Cyanamid.

The swap ratio of 2:5 would imply that BASF India would have to issue around 40 lakh additional shares for the merger (based on Cyanamid Agro's current equity base of Rs 10.09 crore). At the current market price of Rs 94 for the BASF stock, this translates into a sales consideration of around Rs 38 crore. This is less than half of Cyanamid Agro's 1999-2000 sales of Rs 98 crore.

Further downside in Cyanamid Agro

The fact that Cyanamid Agro is expected to almost double its sales figure to around Rs 180 crore (due to the merger of a wholly-owned subsidiary ACCO Industries), throws an unfavourable light on the swap ratio. The swap ratio may be justified on parameters other than sales (such as profit margins, quality of product portfolio and other intangibles). But based on the prevailing market price, a further downside in the Cyanamid Agro stock cannot be ruled out in the near term.

However, it should be noted that with a 69 per cent stake in Cyanamid Agro, BASF AG is also shouldering an equal, if not higher, impact from a markdown in valuations along with the minority shareholders. This suggests that the parent company is optimistic about BASF India's prospects after the merger.

The future

Whatever its near-term impact, from a long-term perspective such a consolidation exercise was probably inevitable for both BASF India and Cyanamid Agro. From a long-term perspective for BASF India, the addition of the Cyanamid portfolio has more positive than negative implications.

Size: As independent entities, both have been relatively small players in the domestic agrochemicals market, trailing behind such players as Syngenta, Aventis CropScience, Rallis, Bayer and Monsanto. Cyanamid Agro, with an expected Rs 180 crore turnover this year, has a 5 per cent share of the domestic agrochemicals market. BASF India, which is a diversified conglomerate, is an even smaller player in the domestic market, with agrochemical operations contributing just around Rs 84 crore or 23 per cent of the turnover of Rs 380 crore in 1999-2000.

The merger of the two is likely to push BASF India ahead of players such as Monsanto, strengthening the product portfolio and distribution clout. Competitors such as Aventis CropScience, Monsanto Chemicals and Syngenta have emerged stronger from restructuring and consolidation exercises of their own. Had they remained standalone entities, both BASF India and Cyanamid Agro may have found it difficult to withstand the competitive pressures.

Broadbased portfolio: Cyanamid Agro's businesses also fit well into BASF India's portfolio. While BASF India's focus has hitherto been on niche herbicide and fungicide products, the Cyanamid acquisition gives it a significant presence in insecticides. While herbicides and fungicides are fast-growing segments of the crop protection industry, insecticides continue to be the largest segment of the Indian market. Cyanamid's presence in this segment dates back several decades and it has several important insecticide brands such as Ripcord, Thimet, Cythion, Stomp and Durmet.

Larger R&D pipeline: Specialty products focussed on specific crops and markets are the key to higher margins in the domestic agrochemical industry. Since original product research calls for astronomical investments, the domestic companies' access to the product pipeline is where MNCs in this business score over their Indian competitors. In this respect, the BASF AG and American Cyanamid merger should give the Indian arm a larger product pipeline to draw from, enhancing its ability to keep up a stream of new product launches.

Cost savings: The integration of operations is likely to result in job cuts and synergistic benefits from combined manufacturing and distribution systems. Cyanamid Agro has already initiated a VRS aimed at pruning its workforce. This could lead to margin expansion for BASF India. In any case, the swap ratio for the merger ensures that BASF India is in a position to acquire the entire operations of Cyanamid Agro at a marginal expansion to its equity base. Based on the swap ratio, BASF India's present equity base of Rs 28.25 crore may see a Rs 4 crore addition post-merger. This does not appear to be a high price to pay for a near 40 per cent addition to turnover.

Minus factors

However, the addition of Cyanamid Agro's operations brings with it certain disadvantages as well.

Greater vulnerability to agricultural cycles: Due to its extensive presence in the insecticides segment, Cyanamid Agro's business appears to be more vulnerable to the fluctuating fortunes of the cotton crop and declining realisations in generic products than BASF India, which is more focussed on specialty herbicides and fungicides.

There is evidence of this in Cyanamid Agro's financial performance over the past two years. Cyanamid Agro followed up a net loss of Rs 6 crore on a turnover of Rs 98 crore in 1999-2000, with a net loss of Rs 6.83 crore on a turnover of Rs 59 crore in the first six months of 2000-01. BASF India, with its more stable product portfolio and contributions from non-crop protection businesses, has managed a better showing, posting increases in net profits both periods.

Greater dependence on crop protection: The addition of Cyanamid Agro's businesses is also likely to raise the contribution of the crop protection business in BASF's overall revenues from the 23 per cent now. This could have negative implications for the valuation of the BASF India stock. The drought in a few major States such as Gujarat, an erratic monsoon and the consequent drop in foodgrains and oilseed outputs are bound to leave the farming community with lower disposable incomes in the medium-term. Prospects for the crop protection industry this year are, therefore, not too bright.

This could cloud valuations for the BASF India stock in the near-term. Major industry players have already seen their valuations marked down sharply this year and are now trading at between 6 and 8 times the latest annual earnings. The BASF India stock has been ruling relatively firm and trades at a price earnings multiple of around 10 times the latest earnings.

Investment outlook

Therefore, despite the obvious benefits from the merger, the uncertain near-term prospects for domestic agrochemical companies could limit the upside potential for the BASF stock in the near term. The poor financial performance from Cyanamid Agro businesses could also weigh on its near-term performance and, thus, on the stock price.

However, investors with a three-year investment horizon can contemplate taking exposure in the BASF India stock at declines in price. Shareholders in Cyanamid Agro may liquidate their holdings at the current levels of Rs 46 considering the further downside potential. Investors with a three-year investment horizon may use any opportunity presented by a decline in the BASF India stock price to build exposures in this stock.